Washington Trading Probe Broadens to Hedge Funds

Brody Mullins, Susan Pulliam and Juliet Chung were first to report that the Securities and Exchange Commission had uncovered a flood of communications between research firm Height Securities and several New York-based hedge funds in an insider-trading investigation. According to sources, the SEC has evidence of more than 20 phone calls, emails and instant messages between investors and analysts at Height Securities between the time of an email alert about a change in government health-care policy and when markets closed. The agency is now looking into whether hedge funds violated securities rules by trading on the resulting alert to Height Securities’ clients.

The story as it appeared on Dow Jones:
Sept. 10, 2014, 4:55 PM EDT: SEC Examines Communications Between Hedge Funds and Height Securities After Health-Policy Alert

4:55 PM EDT: SEC Has Evidence of More Than 20 Calls, Emails, IMs in Minutes After Alert

4:55 PM EDT: Washington Trading Probe Broadens to Hedge Funds

By Brody Mullins, Susan Pulliam and Juliet Chung

WASHINGTON–Federal investigators have uncovered a flurry of communications between Washington research firm Height Securities and several New York-based hedge funds, opening a new front in an insider-trading probe focused on the firm’s 2013 investor alert about a change in government health-care policy.

The Wall Street Journal has previously reported that the Securities and Exchange Commission is investigating whether anyone in the government illegally leaked word of the announcement to the policy-research firm. Now, the agency is looking at whether hedge funds violated securities rules by trading on the resulting alert to Height Securities’ clients.

According to people close to the investigation, the SEC has evidence of more than 20 phone calls, emails and instant messages between investors and analysts at Height Securities between the time the firm sent the email alert and when markets closed.

The existence of phone calls and emails between Height Securities and its Wall Street customers in the moments before the government made its announcement wasn’t previously known. Officials at Point72, Viking and Visium declined to comment. A lawyer for Height declined to comment but has said previously that the company did nothing wrong.

Katie Spring, a Citadel spokeswoman, said: “Our communication was for the sole purpose of verifying information contained in what we understood to be a broadly disseminated email, and was part of our compliance process specifically undertaken at the behest of our compliance team.”

Ms. Spring declined to talk about any information that was shared between Height Securities and the hedge fund at the time.

There is nothing inherently illegal about investors talking with individuals at Height Securities about its research note. In fact, it would be normal for them to do so before making a large trade based on a research note. But investors could be liable for violating insider-trading rules if they knew the information was obtained illegally–or if they should have known that the information was obtained illegally. As a result, the information relayed in the communications between Height and the hedge funds is critical.

Investigators haven’t alleged any wrongdoing on the part of Height or the hedge funds.

At issue is a series of events in the hours before the federal Centers for Medicare and Medicaid Services announced it would reverse course on planned funding cuts for private insurance plans. The shift was a boon to health-insurance firms, and their stocks went on a tear when news of it came out.

The probe has become the centerpiece of the SEC’s efforts to investigate Washington’s political-intelligence industry. Investigators believe it represents one of their best chances to determine whether or not the flourishing Washington business of ferreting out tips about policy changes for investors violates insider-trading laws.

The content of the communications between Height and its clients could help the SEC determine whether any of Height’s investor clients violated the law in any trading of health-insurance stocks that day.

Under standard insider-trading rules, the SEC must prove that an investor traded on the basis of nonpublic, material information that was obtained in violation of a duty. Securities lawyers say the SEC can also pursue civil charges if investors “recklessly ignore a substantial risk” that they were trading on insider information.

“To pursue charges against the trader, the government would need to prove that he knew or had reason to know that the original tipper breached a duty by disclosing the information,” said Justin Shur, a former federal prosecutor now with MoloLamken LLP. “Thus, figuring out what the trader knew about the source of the information is critical for prosecutors,” he said.

That makes it important for the SEC to determine what information was relayed between Height Securities and its investor clients in the phone calls, emails and instant messages that followed its blast email.

At 3:42 p.m., on April 1, 2013, Height Securities sent an email alert to more than 150 investor clients predicting the government announcement. After markets closed, CMS sent a news release at 4:22 p.m. that day announcing that it would, indeed, restore the spending cuts.

In its filings, the SEC has said it is reviewing trading by 44 hedge funds and other investors who received the email alert from Height and traded shares in health-insurance firms ahead of the CMS announcement.

The SEC hasn’t determined whether information relayed by Height Securities that day violated securities rules. Investigators are still looking into whether anyone in Washington broke insider-trading rules by relaying word of the government decision to Wall Street.

If no one violated securities rules in obtaining the information, then investors who traded based on Height’s email wouldn’t face any potential liability.

According to emails and documents made public as part of the investigation, a CMS official with knowledge of the decision spoke with a top congressional health-care aide in the days before CMS announced its decision.

That aide, Brian Sutter, later spoke on the phone about the decision with Mark Hayes, a health-care lobbyist who previously had worked for Height Securities. About 10 minutes later, at 3:12 p.m. on April 1, Mr. Hayes sent an email to Height Securities saying that informed sources told him CMS would reverse course on its planned funding cuts for private health insurers. The SEC has said in court papers it believes that Mr. Sutter could have been a source for Mr. Hayes’s prediction.

A lawyer for Mr. Hayes said that his client “did not possess any nonpublic information” and “did nothing improper.” A spokesman for Mr. Sutter declined to comment. A lawyer for Mr. Sutter has previously said that Mr. Sutter didn’t share nonpublic information.

The SEC has also said it doesn’t know if the CMS official who spoke with Mr. Sutter shared the news of the pending decision. In May, the SEC issued a subpoena to Mr. Sutter to compel him to turn over records related to his communications with CMS and the lobbyist.

Through lawyers for the U.S. House of Representatives, Mr. Sutter refused to comply with the subpoena. In June, the SEC filed a federal lawsuit seeking to force Mr. Sutter to turn over his records to investigators.

A federal judge is expected to issue a ruling on the case shortly.

Andrew Ackerman contributed to this article.

Write to Brody Mullins at brody.mullins@wsj.com, Susan Pulliam at susan.pulliam@wsj.com and Juliet Chung at juliet.chung@wsj.com

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